WISAL KAMAL FABRICS (PVT.) LTD., LAHORE VS COMMISSIONER INLAND REVENUE, LAHORE, 2019 PTD-LAHORE-HIGH-COURT-LAHORE 1077 (2018)

Income Tax Ordinance (XLIX of 2001)---

----Ss. 18(1)(d), 122(5A) & 133---Reference---Tax liability, determina-tion of---Interest free loans by directors of company---Nature---Taxpayer was receiving interest free loans extended by its directors which was declared as taxpayer's benefits by tax authorities---Taxpayer's appeal before Appellate Tribunal Inland Revenue was dismissed ex-parte---Validity---No business relationship existed between taxpayer and its directors---Directors were managing taxpayers and had a fiduciary relationship with taxpayer, as such they were not engaged in business relationship with taxpayer hence, interest free loans given by directors given to taxpayer did not fall within meaning of "benefit derived during course of business relationship"---Provisions of S. 18(1)(d) of Income Tax Ordinance, 2011 were not applicable for the purposes of determining tax liability---High Court set aside order passed by Appellate Tribunal Inland Revenue---Reference was allowed in circumstances.

Commissioner Inland Revenue, Zone-II v. Lucky Cotton Mills (Pvt.) Ltd. 2017 PTD 864 and 2015 PTD (Trib.) 386 ref.

Mohammad Saqib Jillani for Appellant.

Javed Athar for Respondents.

Date of hearing: 5th November, 2018.

JUDGMENT

AYESHA A. MALIK, J.---This Reference along with connected References being ITRs Nos.221219/18 and 221226/18 have been filed by the Applicant under section 133 of the Income Tax Ordinance, 2001 ("Ordinance") involving common questions of law.

2.The following questions of law have been raised in all three Reference, which are asserted to have arisen out of order dated 3.10.2017 passed by the Appellate Tribunal Inland Revenue, Lahore Bench, Lahore ("Appellate Tribunal"):--

i)"Whether the learned ATIR was justified to pass the order based on assumptions, which is not sustainable in the eyes of law being against the spirit of section 122(5A) of the Income Tax Ordinance, 2001 in tax years 2010, 2011, 2012?"

ii)"Whetherthelearned ATIRwasjustifiedtotreatprovisionof interest free loan given to the petitioner by the directors/sponsors as benefit and chargeable with Income Tax in terms of section 18(1)(d) of the Ordinance in respect of tax years 2010, 2011, 2012 which was even otherwise contrary to judgment of Sindh High Court titled 'Commissioner Inland Revenue v. Lucky Cotton Mills (Pvt.) Limited' reported as 2017 PTD 864 wherein it was held that no business relationship in terms of section 18(1)(d) of the Income Tax Ordinance existed between company and its Directors who had advanced interest free loan to the company. The Honourable High Court disapproved/rejected the treatment of loan by director as 'income from business' and held that such benefit could not be termed a taxable benefit under section 18(1)(d) of the Income Tax Ordinance."

3.An assessment order was passed for the tax years 2010, 2011 and 2012 where after proceedings under Section 122(5A) of the Ordinance were initiated to amend the assessment. The amendment order was passed on 8.3.2016 whereby the Applicant is aggrieved. The main grievance of the Applicant is that interest free loans in the amount of Rs.168,250,000/-, Rs. 143,254,000/- and Rs. 11,317,995/- were given by the Directors of the Applicant Company to the Company which loans were treated as benefits of the company chargeable to income tax under Section 18(1)(d) of the Ordinance. Consequently the Commissioner applied a random rate of 13.5% to calculate interest and raised a demand for Rs.22,713,750/- as tax liability of the Applicant. The Applicant filed an appeal before the Commissioner Inland Revenue (Appeals-II), Lahore who upheld the original assessment order dated 8.3.2016 vide order dated 7.6.2016. The Applicant then filed appeal before the Appellate Tribunal which passed an ex-parte order dated 3.10.2017 and dismissed the appeal without hearing or considering the grounds of the Applicant.

4.Learned counsel for the Applicant argued that the grounds were provided for in the appeal yet the requirements of Section 18(1)(d) of the Ordinance were not taken into consideration. Learned counsel stated that this matter has been decided by the Hon'ble Sindh High Court in the case cited at Commissioner Inland Revenue, Zone-II v. Lucky Cotton Mills (Pvt.) Ltd. (2017 PTD 864). Further stated that the Inland Revenue Appellate Tribunal has also decided the same issue in another case cited at 2015 PTD (Trib.) 386 in line with the judgment of the Hon'ble Sindh High Court yet a different meaning is being given to Section 18(1)(d) of the Ordinance in the present proceedings by the Respondents.

5.The basic contention of the Applicant is that Section 18(1)(d) of the Ordinance provides that any benefit derived by a person will be chargeable to income tax under the head of business income. The benefit can be derived by virtue of past, present or prospective business relationships. Learned counsel argued that the directors of a private limited Company, in this case Applicant Company, do not have a business relationship with the Company. Learned counsel argued that this matter was considered in 2017 PTD 864 (supra) wherein it was held that there is no business relationship between the company and its directors. Accordingly any interest free loan given to the company by the director cannot be made chargeable to income tax under Section 18(1)(d) of the Ordinance.

6.On behalf of Respondent No.1, it is argued that the relationship between the company and its director is a business relationship. He further argued that the case was heard and decided ex-parte because the Applicant did not present itself on the date when the case was fixed.

7.We have heard the learned counsel for the parties and gone through the record. The fact that the impugned order was passed ex-parte did not absolve the Appellate Tribunal from considering the law applicable to the case of the Applicant. The case of the Applicant is that two Directors of the Applicant Company advanced interest free loans to the company from time to time, which has been made chargeable to income tax under Section 18(1)(d) of the Ordinance for the tax years 2010, 2011 and 2012. Section 18(1)(d) of the Ordinance reads as under:--

Income from business (1).---The following incomes of a person for a tax year, other than income exempt from tax under this Ordinance, shall be chargeable to tax under the head "Income from Business"

(d)the fair market value of any benefit or perquisite, whether convertible into money or not, derived by a person in the course of, or by virtue of, a past, present, or prospective business relationship

For the purposes of this clause, it is declared that the word `benefit' includes any benefit derived by way of waiver of profit on debt or the debt itself under the State Bank of Pakistan, Banking Policy Department's Circular No.29 of 202 or in any other scheme issued by the State Bank of Pakistan.

The statute basically states that any benefit derived by a person during the course of a business relationship is chargeable to income tax for the purposes of charging tax. The key requirement is that the benefit must be derived during the course of a business relationship. There is no business relationship between the company and its directors as the directors are managing the company and have a fiduciary relationship with the company. As such they are not engaged in a business relationship with the company. Hence interest free loans given by directors to the company do not fall within the meaning of benefit derived during the course of a business relationship, meaning that the provisions of section 18(1)(d) of the Ordinance are not applicable for the purposes of determining the tax liability.

8.In these cases of the Commissioner Inland Revenue and the Appellate Tribunal agreed with the views contained in the original order dated 8.3.2016 which is not in consonance with the law. The Hon'ble Sindh High Court in 2017 PTD 864 (supra) has also expressed the same view. Interestingly the Inland Revenue Appellate Tribunal also expressed the same view in 2015 PTD (Trib.) 386 (supra) yet has adopted a totally different interpretation in this case.

9.Therefore, under the circumstances, Reference applications are decided in favour of the Applicant and impugned order dated 3.10.2017 passed by the Appellate Tribunal is set aside to the extent of interest free loan.

10.Office shall send a copy of this order under seal of the Court to the Appellate Tribunal as per Section 133(5) of the Ordinance.

MH/W-3/LReference allowed.